Risk Analysis and Management of Petroleum Exploration Ventures
During the 1990s, many international petroleum companies improved their exploration performance significantly by using principles of risk analysis and portfolio management, in combination with new geotechnologies. While exploration risk cannot be eliminated, it can certainly be reduced substantially, on a portfolio scale. And the widespread adoption of standardized risk analysis methods during the 1990s brought badly needed discipline to petroleum exploration. By the mid-1980s, most well-informed major international petroleum firms that were engaged in exploration recognized that, globally, the average size of new discoveries was diminishing. Not coincidentally, the class of exploratory prospects categorized as “high risk/high-potential” was showing marked signs of underperformance. For major companies, when all such ventures, which averaged around a 10% perceived probability of success, were considered, less than 1% actually discovered profitable oil and gas reserves, and the sizes of these discoveries were generally far smaller than predicted. All in all, such exploration for new giant fields destroyed value, rather than creating it, in the 1980s and early 1990s. Consequently, exploration, as a corporate function, lost credibility. It badly needed to begin delivering on its corporate promises. It needed to become more efficient, and thereby more profitable. To optimize the allocation of exploration capital, concepts of portfolio management began to be considered.
Exploration Plays—Risk Analysis and Economic Assessment
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Published:January 01, 2001
Abstract
No rational investor wants to make a large payment for a purchase whose quantity, quality, and longevity are largely unknown. However, that is essentially what is required of most modern petroleum firms that seek to explore and develop new prospective areas.
To obtain contractual rights to explore for and develop petroleum resources in most countries, a cor-poration usually must commit to spending millions of dollars, either through work commitments (line-miles of seismic surveys, number of drilled wells, and the like) or front-end payments (bonus bids, fees, and the like), or both. Frequently, such financial commitments are undertaken with only minimal knowledge about the prospectivity of the contract area—how many new fields may be discovered; how much oil and/or gas they may contain; how much it may cost to find, develop, and produce them; how profitable they may be; how long it may take to establish production; and how long the productive life of the fields may be.
Ideally, such exploration would be staged: progressive investments would be closely related to the ongoing acquisition of geotechnical, economic, and political information bearing on evolving perceptions of risk versus reward, thus minimizing unnecessary expenditures. However, the form of most existing international contracts prevents such prudent investing.
Thus the most critical decision in modern petroleum exploration is not which prospect to drill. Rather, it is which new trend or area to go into, because that decision commits the organization to millions of invested dollars, years of involvement, and hundreds of man-years of professional and technical effort.
